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NISM Series XVI practice questions

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Question 1Introduction to Commodity Markets

In commodity market terminology, what does a 'spot market' refer to?

  1. A market where delivery and payment occur immediately or within a very short settlement period Correct answer.
  2. A market where only futures contracts with monthly expiries are traded
  3. A market restricted to government-approved importers
  4. A market where prices are fixed by the exchange each morning

Explanation

The spot market, also called the cash or physical market, is where commodities are traded for near-immediate delivery and settlement rather than for a future date. Prices here reflect current physical supply and demand and are often used as a reference for derivative pricing. Futures markets, by contrast, involve deferred settlement.

Question 2Introduction to Commodity Markets

Which of the following best describes a derivative contract in commodity markets?

  1. A contract whose value is derived from an underlying commodity or reference price Correct answer.
  2. A contract used only by farmers to insure their crops
  3. A contract that always requires physical delivery of the commodity
  4. A contract issued by a bank guaranteeing a fixed interest rate

Explanation

A derivative is a financial instrument whose value depends on an underlying asset, index, or reference rate, such as a commodity price. Commodity futures, options, and swaps are all derivatives. Physical delivery is only one possible settlement route and is not a defining requirement.

Question 3Introduction to Commodity Markets

What is hedging in the context of commodity markets?

  1. Speculating on price direction without any underlying exposure
  2. Setting a price ceiling imposed by a regulator
  3. Taking an offsetting position to reduce exposure to adverse price movements Correct answer.
  4. Buying and selling the same commodity simultaneously on two exchanges for profit

Explanation

Hedging means taking a position in a derivative or related market that offsets the price risk arising from a physical or financial exposure. The goal is to lock in a price or reduce volatility, not to earn speculative profit. A hedger typically has an existing commercial exposure.

Question 4Introduction to Commodity Markets

Which of the following commodities is classified as a 'soft' commodity?

  1. Copper
  2. Gold
  3. Crude oil
  4. Coffee Correct answer.

Explanation

Soft commodities are typically agricultural products that are grown rather than mined, such as coffee, sugar, cocoa, and cotton. Metals and energy products are hard commodities. The distinction is based on how the commodity is produced.

Question 5Introduction to Commodity Markets

What is the primary economic function of a futures exchange in commodity markets?

  1. To set the physical quality standards for all global producers
  2. To guarantee profits for all participants
  3. To provide a regulated platform for price discovery and risk transfer Correct answer.
  4. To fix the final retail price of commodities

Explanation

A futures exchange provides a centralized, regulated marketplace where buyers and sellers discover prices and transfer price risk through standardized contracts. It also operates clearing and settlement infrastructure. It does not guarantee profits or dictate retail prices.

Question 6Introduction to Commodity Markets

Which body in India is the statutory regulator for the securities and commodity derivatives markets?

  1. Insurance Regulatory and Development Authority of India (IRDAI)
  2. Forward Markets Commission (FMC)
  3. Securities and Exchange Board of India (SEBI) Correct answer.
  4. Reserve Bank of India (RBI)

Explanation

SEBI regulates the securities market and, following the merger of the Forward Markets Commission with SEBI in 2015, also regulates commodity derivatives. The RBI handles monetary policy and banking regulation. The FMC was the earlier commodity regulator but no longer exists separately.

Question 7Introduction to Commodity Markets

What is a 'forward contract' in commodity trade?

  1. A government-issued license to import a commodity
  2. A standardized exchange-traded contract cleared by a central counterparty
  3. A customized bilateral agreement to buy or sell a commodity at a future date at a price agreed today Correct answer.
  4. An option granting the right but not the obligation to buy a commodity

Explanation

A forward contract is a privately negotiated, non-standardized agreement between two parties to exchange a commodity at a specified future date and price. It is not exchange-traded and carries counterparty risk. Futures contracts are the standardized, exchange-cleared equivalent.

Question 8Introduction to Commodity Markets

Which of the following is a key characteristic of a futures contract?

  1. It is traded only over the counter
  2. It can be customized freely by the two counterparties
  3. It is standardized in terms of quantity, quality, and delivery period Correct answer.
  4. It always requires physical delivery of the underlying

Explanation

Futures contracts are standardized by the exchange with respect to contract size, deliverable grade, delivery month, and tick size, which makes them fungible and easy to trade. This standardization distinguishes them from customized forward contracts. Physical delivery is only one settlement option.

Question 9Introduction to Commodity Markets

A jeweller expects to buy gold in three months and fears a price rise. Which action best illustrates a hedging application?

  1. Buy gold futures now to lock in a purchase price Correct answer.
  2. Sell gold futures now to profit from a price fall
  3. Buy gold in the spot market today and store it
  4. Wait for prices to fall before buying

Explanation

A buyer facing future price risk hedges by taking a long futures position, which gains value if prices rise and offsets the higher cost of physical purchase. Selling futures would hedge a seller's inventory, not a buyer's requirement. Waiting exposes the jeweller to price risk.

Question 10Introduction to Commodity Markets

An oil producer wants protection against falling crude prices over the next quarter. Which position is the appropriate hedge?

  1. Buy crude oil futures
  2. Buy crude oil in the spot market
  3. Buy a call option on crude oil
  4. Sell crude oil futures Correct answer.

Explanation

A producer holding physical crude is long the commodity and hedges by taking a short futures position. If prices fall, the gain on the short futures offsets the lower sale value of the physical oil. Buying futures or calls would add to the producer's long exposure.

Question 11Introduction to Commodity Markets

What does 'contango' describe in a commodity futures market?

  1. A situation where futures prices are higher than the spot price Correct answer.
  2. A market where the exchange suspends trading
  3. A market where no trading occurs
  4. A situation where futures prices are lower than the spot price

Explanation

Contango is a market structure where futures prices exceed the current spot price, often reflecting storage, insurance, and financing costs. The opposite situation, where futures trade below spot, is backwardation. These terms describe the shape of the forward curve.

Question 12Introduction to Commodity Markets

Which of the following best explains why commodity prices are said to be mean-reverting in the long run?

  1. High prices encourage supply and reduce demand, pushing prices back toward production costs Correct answer.
  2. Prices always rise over time due to inflation
  3. Speculators are legally required to trade against the trend
  4. Futures exchanges set prices within fixed bands

Explanation

Commodity prices tend to revert to long-run levels because high prices stimulate new supply and dampen demand, while low prices discourage production. This supply-demand response anchors prices around marginal production costs. Exchanges do not fix prices within bands.

Question 13Introduction to Commodity Markets

What is the role of a clearing corporation in commodity futures trading?

  1. It acts as the central counterparty to every trade and manages default risk Correct answer.
  2. It provides loans to farmers for crop production
  3. It sets the spot price of the commodity each day
  4. It approves the physical quality of imported goods

Explanation

The clearing corporation interposes itself between buyer and seller, becoming the central counterparty and guaranteeing settlement. It collects margins and operates a settlement guarantee fund to manage default risk. It does not set spot prices or lend to farmers.

Question 14Introduction to Commodity Markets

A trader buys one futures contract at Rs 5,000 and the contract lot size is 100 units. If the price rises to Rs 5,050, what is the trader's gross profit?

  1. Rs 5,000 Correct answer.
  2. Rs 50
  3. Rs 500
  4. Rs 50,000

Explanation

Gross profit equals the price change multiplied by the lot size: (5,050 − 5,000) × 100 = Rs 5,000. The lot multiplier converts the per-unit price movement into the contract's monetary value. Ignoring the multiplier is a common error.

Question 15Introduction to Commodity Markets

Which of the following is an example of a market participant classified as a speculator?

  1. A fund that takes positions purely to profit from anticipated price movements Correct answer.
  2. A flour mill hedging its wheat purchase requirement
  3. A farmer locking in a sale price for the coming harvest
  4. A bank holding physical gold as part of its reserves

Explanation

Speculators take positions to profit from expected price changes without an underlying commercial exposure. They add liquidity to the market and absorb risk transferred by hedgers. The other options describe participants with genuine physical exposure seeking to reduce risk.

Question 16Introduction to Commodity Markets

What is 'basis' in commodity hedging?

  1. The commission charged by a broker on each trade
  2. The minimum margin required to open a position
  3. The difference between the spot price and the futures price of the same commodity Correct answer.
  4. The difference between two consecutive futures expiries

Explanation

Basis is defined as the spot price minus the futures price of the same commodity, or sometimes the reverse depending on convention. Changes in basis create basis risk, which remains even after a hedge is placed. Brokerage, margin, and calendar spreads are distinct concepts.

Question 17Introduction to Commodity Markets

Why does a commodity futures exchange prescribe deliverable grades and quality specifications?

  1. To set the retail price of the commodity
  2. To ensure that contracts are fungible and can be settled uniformly Correct answer.
  3. To allow sellers to deliver any quality they choose
  4. To prevent buyers from taking delivery

Explanation

Standardized quality specifications make contracts fungible, so a buyer can accept delivery from any seller without inspecting each lot individually. This supports efficient clearing and settlement. It does not permit arbitrary quality or set retail prices.

Question 18Introduction to Commodity Markets

What distinguishes an option from a futures contract in terms of obligation?

  1. Both create equal obligations for buyer and seller
  2. A futures contract can be cancelled at will without cost
  3. An option buyer has a right but no obligation, while a futures position creates an obligation for both parties Correct answer.
  4. An option creates an obligation for the buyer only

Explanation

The option buyer pays a premium for the right, but not the obligation, to exercise the contract, whereas the option writer is obligated. In a futures contract, both parties are bound to honor the contract or offset it before expiry. This asymmetry in rights and obligations is fundamental.

Question 19Introduction to Commodity Markets

Which type of risk arises because a hedger's physical commodity may not exactly match the futures contract specification?

  1. Basis risk Correct answer.
  2. Liquidity risk
  3. Credit risk
  4. Operational risk

Explanation

Basis risk arises when the hedger's physical exposure differs from the futures contract in grade, location, or timing, so the hedge does not perfectly offset price changes. The spot-futures price relationship can move against the hedger. Credit, operational, and liquidity risks are separate categories.

Question 20Introduction to Commodity Markets

In India, which of the following is a recognized national commodity derivatives exchange?

  1. National Payments Corporation of India (NPCI)
  2. Multi Commodity Exchange of India (MCX) Correct answer.
  3. Bombay Stock Exchange (BSE)
  4. National Stock Exchange of India (NSE)

Explanation

MCX is a dedicated commodity derivatives exchange in India. NSE and BSE are primarily securities exchanges, though they have commodity derivatives segments with regulatory approval. NPCI is a payments infrastructure entity, not an exchange.

Question 21Introduction to Commodity Markets

A commodity futures contract trades at Rs 4,200 for the near month and Rs 4,350 for the next month. What does this price relationship indicate?

  1. The exchange has fixed the spread
  2. The near-month contract is overpriced
  3. The market is in backwardation
  4. The market is in contango Correct answer.

Explanation

When the deferred futures price exceeds the near-month price, the forward curve slopes upward, a condition known as contango. This typically reflects carrying costs such as storage and financing. Backwardation would show the opposite pattern.

Question 22Introduction to Commodity Markets

What is the primary purpose of margin requirements in commodity futures trading?

  1. To serve as a performance bond that mitigates counterparty default risk Correct answer.
  2. To guarantee a profit for the trader
  3. To set the minimum price of the commodity
  4. To cover the exchange's marketing expenses

Explanation

Margin is a performance deposit collected to ensure that participants can meet their obligations if prices move against them. It protects the clearing system from default rather than guaranteeing profit. Margins are adjusted by the exchange based on volatility and risk.

Question 23Introduction to Commodity Markets

A trader is long 10 futures contracts of lot size 50 at Rs 2,000. The price falls to Rs 1,980 and the contract is marked to market. What is the mark-to-market loss?

  1. Rs 20
  2. Rs 100,000
  3. Rs 1,000
  4. Rs 10,000 Correct answer.

Explanation

The loss per unit is Rs 20 (2,000 − 1,980), and the total exposure is 10 contracts × 50 units = 500 units, giving Rs 20 × 500 = Rs 10,000. Mark-to-market settlement debits or credits this amount to the trader's margin account daily.

Question 24Introduction to Commodity Markets

Which statement best explains the economic rationale for the existence of commodity derivatives markets?

  1. They eliminate all price volatility in the underlying commodity
  2. They replace the physical market entirely
  3. They guarantee a fixed return to all participants
  4. They enable the transfer of price risk from hedgers to risk-takers and facilitate price discovery Correct answer.

Explanation

Derivatives markets allow those with price exposure to transfer risk to participants willing to bear it, while the interaction of buyers and sellers generates forward-looking prices. Volatility is not eliminated; it is redistributed. Physical markets continue to function alongside derivatives.

Question 25Introduction to Commodity Markets

A commodity futures market is in backwardation. Which of the following is a plausible explanation?

  1. The exchange has raised margin requirements
  2. Interest rates have increased sharply
  3. Storage costs are unusually high and rising
  4. Immediate physical supply is tight, so spot prices exceed deferred futures prices Correct answer.

Explanation

Backwardation often reflects a convenience yield when current physical supply is scarce, making spot or near-term prices higher than deferred prices. High storage costs and interest rates tend to encourage contango, not backwardation. Margin changes affect trading costs, not the term structure directly.

Question 26Introduction to Commodity Markets

In commodity market terminology, what does the 'spot price' refer to?

  1. The price at which a commodity was last delivered on the exchange
  2. The price of the most actively traded futures contract
  3. The average of all futures prices across contract months
  4. The price agreed today for immediate delivery and payment Correct answer.

Explanation

The spot price is the price in the cash or physical market for immediate delivery and settlement of a commodity. It is distinct from futures prices, which are for delivery at a later date. Spot prices are typically quoted by traders, producers, or price reporting agencies rather than being centralised on an exchange.

Question 27Introduction to Commodity Markets

Which of the following best describes the role of a commodity exchange's trade repository or clearing member in the settlement process?

  1. It sets the spot price for the underlying commodity each day
  2. It provides margin funding to all market participants at zero cost
  3. It guarantees physical delivery of every contract traded
  4. It acts as the central counterparty to trades and manages settlement risk Correct answer.

Explanation

A clearing corporation or clearing member interposes itself between buyers and sellers, becoming the central counterparty, and manages settlement risk through margining and a settlement guarantee fund. It does not itself guarantee delivery of physical goods in all cases, nor does it set spot prices. Its core function is to reduce counterparty risk.

Question 28Introduction to Commodity Markets

A commodity futures contract specifies a 'tick size'. What does tick size mean?

  1. The maximum daily price movement allowed
  2. The minimum price fluctuation permitted for the contract Correct answer.
  3. The brokerage charged per trade
  4. The number of units in one lot

Explanation

Tick size is the smallest price increment by which a futures contract can move. For example, if the tick size is Rs 1, prices can be quoted as Rs 100, Rs 101, etc., but not Rs 100.50. It is distinct from the daily price limit and from the contract lot size.

Question 29Introduction to Commodity Markets

Which of the following is a key difference between a commodity futures contract and a commodity forward contract?

  1. Forwards require margin, while futures do not
  2. Forwards are regulated by the securities regulator, while futures are not
  3. Futures always result in physical delivery, while forwards are always cash-settled
  4. Futures are standardised and exchange-traded, while forwards are customised and over-the-counter Correct answer.

Explanation

Futures contracts are standardised in terms of quantity, quality, delivery date, and location, and are traded on regulated exchanges. Forward contracts are privately negotiated, customised agreements between two parties, typically traded over-the-counter. This standardisation is what allows futures to be easily offset before delivery.

Question 30Introduction to Commodity Markets

A commodity trader wants to know the total value of one futures contract. Which formula should the trader use?

  1. Futures price divided by the tick size
  2. Futures price multiplied by the contract lot size Correct answer.
  3. Futures price multiplied by the tick size
  4. Initial margin multiplied by the number of contracts

Explanation

The contract value, also called notional value, is the futures price multiplied by the lot size (number of units per contract). For example, if the price is Rs 5,000 and the lot size is 100 units, the contract value is Rs 5,00,000. This value is used to calculate margin requirements and mark-to-market gains or losses.

Question 31Introduction to Commodity Markets

Which of the following best explains why commodity futures prices are often used as a reference for physical trade pricing?

  1. Futures prices are set by the government and are therefore reliable
  2. Futures markets aggregate information and provide transparent, publicly available prices Correct answer.
  3. Futures prices are always lower than spot prices
  4. Futures markets eliminate all price risk for physical traders

Explanation

Futures exchanges provide a centralised, transparent marketplace where many participants trade, and the resulting prices reflect the collective view of supply and demand. These prices are widely disseminated and are therefore used as a benchmark for pricing physical transactions. They do not eliminate risk but allow it to be managed.

Question 32Introduction to Commodity Markets

What is the primary function of a commodity exchange's warehouse receipt system?

  1. To provide a document that evidences ownership of stored commodity and facilitates delivery Correct answer.
  2. To finance the purchase of the commodity
  3. To insure the commodity against all types of loss
  4. To guarantee a fixed price for the stored commodity

Explanation

A warehouse receipt is a document issued by an accredited warehouse that confirms the quantity and quality of goods stored. It serves as evidence of ownership and is used in the delivery process for commodity futures contracts. It may also be used as collateral for financing, but that is not its primary function.

Question 33Introduction to Commodity Markets

Which of the following is a characteristic of a commodity index?

  1. It tracks the performance of a basket of commodity futures contracts Correct answer.
  2. It represents the physical spot price of a single commodity
  3. It guarantees a fixed return to investors
  4. It is a type of equity index

Explanation

A commodity index measures the performance of a diversified basket of commodity futures, often weighted by production or liquidity. It provides exposure to a broad commodity market rather than a single commodity. It does not guarantee returns and is distinct from equity indices.

Question 34Introduction to Commodity Markets

A trader observes that the futures price of a commodity is lower than its expected spot price at maturity. This situation is most likely to encourage which action?

  1. Avoiding the futures market altogether
  2. Buying the spot commodity and storing it without hedging
  3. Selling the futures contract and buying in the spot market
  4. Buying the futures contract and taking delivery Correct answer.

Explanation

If the futures price is below the expected spot price at maturity, a trader can buy the futures contract now and take delivery at the lower futures price, then sell at the higher spot price. This is a form of cash-and-carry arbitrage in reverse, often seen in backwardated markets. It assumes storage and transaction costs do not eliminate the opportunity.

Question 35Introduction to Commodity Markets

What is the role of a designated delivery center in a commodity futures exchange?

  1. To publish research reports on commodity prices
  2. To act as the clearing corporation for all trades
  3. To provide a location where physical delivery can be made according to contract specifications Correct answer.
  4. To set the daily price limits for the contract

Explanation

A designated delivery center is a specific location, often a warehouse or storage facility, approved by the exchange where sellers can deliver the physical commodity to fulfil futures contracts. It ensures that delivery occurs at a known and regulated place, reducing disputes. It does not set price limits or clear trades.

Question 36Introduction to Commodity Markets

Which of the following participants in commodity futures markets is most likely to be classified as a hedger?

  1. A farmer who sells futures to lock in a price for the upcoming harvest Correct answer.
  2. A retail investor who buys futures based on technical charts
  3. A proprietary trading firm that takes positions to profit from short-term price movements
  4. A market maker who provides liquidity by quoting both bid and ask

Explanation

A hedger uses futures to reduce or offset price risk in an existing or anticipated physical position. A farmer selling futures to lock in a selling price for the harvest is hedging against a fall in prices. Speculators, such as proprietary traders and retail investors, take positions to profit from price changes and do not have an offsetting physical exposure.

Question 37Introduction to Commodity Markets

In the context of commodity derivatives, what does 'open interest' measure?

  1. The total number of outstanding futures contracts that have not been closed or delivered Correct answer.
  2. The total value of margin deposited with the exchange
  3. The number of participants who have declared their intention to deliver
  4. The total volume of trades executed during a trading session

Explanation

Open interest is the number of futures contracts that are currently active and have not been offset or settled by delivery. It is often used as an indicator of market liquidity and participation. Volume, in contrast, counts the number of trades executed in a given period.

Question 38Introduction to Commodity Markets

A commodity exchange introduces a new futures contract. Which of the following is typically NOT a standardised element in the contract specification?

  1. Contract lot size
  2. Delivery month and location
  3. The identity of the counterparty to each trade Correct answer.
  4. Quality grade of the deliverable commodity

Explanation

Futures contracts standardise quantity, quality, delivery time, and location, but not the identity of the counterparty. The clearing corporation becomes the counterparty to every trade, anonymising the parties. This anonymity is a key feature that reduces counterparty risk.

Question 39Introduction to Commodity Markets

What is the purpose of a 'variation margin' in commodity futures trading?

  1. To cover the initial deposit required to open a position
  2. To pay the exchange's transaction fees
  3. To bring the margin account back to the required level after adverse price movements Correct answer.
  4. To provide a loan to the trader for trading

Explanation

Variation margin is the daily cash flow that reflects the mark-to-market gains or losses on a futures position. When the account falls below the maintenance margin level, a variation margin call requires the trader to deposit additional funds to restore the balance. Initial margin is the upfront deposit, not the variation margin.

Question 40Introduction to Commodity Markets

Which of the following best explains why commodity futures markets are considered to facilitate price risk management for the broader economy?

  1. They set a maximum price for essential commodities
  2. They allow producers and consumers to transfer price risk to willing speculators Correct answer.
  3. They guarantee that commodity prices will remain stable
  4. They eliminate the need for physical storage of commodities

Explanation

Commodity futures markets enable hedgers to transfer the risk of adverse price movements to speculators who are willing to bear that risk in pursuit of profit. This risk transfer helps producers and consumers plan and stabilise their cash flows. It does not guarantee price stability or eliminate storage needs.

Question 41Commodity Futures and Options

On a commodity derivatives exchange, which margin is collected to cover the potential one-day loss on a futures position and is recalculated using statistical models such as VaR?

  1. Initial margin Correct answer.
  2. Mark-to-market margin
  3. Delivery margin
  4. Special margin

Explanation

Initial margin, also called daily or SPAN-type margin, is the upfront amount set by the clearing corporation to cover the probable loss over a defined horizon, typically using value-at-risk or scenario-based models. It is recalculated as volatility and price levels change, and it is distinct from the daily mark-to-market settlement flow.

Question 42Commodity Futures and Options

A trader holds a long position of 10 lots in a crude oil futures contract at the time of expiry and is not permitted to square off because the contract has entered the delivery period. What is the standard consequence?

  1. The position results in a delivery obligation with associated delivery and penalty provisions Correct answer.
  2. The position is automatically cash-settled at the final settlement price
  3. The exchange assigns the position to a willing seller for cash settlement
  4. The position is carried forward to the next contract month at the same price

Explanation

Commodity futures contracts that permit physical delivery create a binding obligation once the delivery notice period begins; a long must take delivery of the underlying and arrange payment and logistics. Exchanges impose delivery margins and penalties for default, and positions are not silently rolled or cash-settled unless the contract is explicitly cash-settled.

Question 43Commodity Futures and Options

Which of the following best describes a commodity futures 'basis'?

  1. The difference between the opening and closing price of a futures contract on a single trading day
  2. The amount by which the initial margin exceeds the maintenance margin
  3. The spread between the futures price of two different exchanges for the same commodity
  4. The difference between the spot price of a commodity and the price of the relevant futures contract Correct answer.

Explanation

Basis is normally defined as the local spot or cash price minus the futures price of the relevant contract, and it reflects transport, storage, quality and local supply-demand factors. Traders use basis to judge whether to hedge and to measure hedging effectiveness, since basis risk remains even after a hedge is placed.

Question 44Commodity Futures and Options

An oil refiner expects to buy crude oil in three months but fears a price rise. Which hedge should the refiner place?

  1. Sell refined product futures and buy crude futures simultaneously
  2. Sell crude oil futures now and buy them back at the time of purchase
  3. Do nothing, because a refiner is naturally long crude oil
  4. Buy crude oil futures now and sell them at the time of purchase Correct answer.

Explanation

A party that will buy the physical commodity is short the underlying exposure and hedges by going long futures, so gains on the futures offset a higher purchase price. This is a classic long hedge for a consumer or processor of the commodity.

Question 45Commodity Futures and Options

In commodity options, what does the 'delta' of an option measure?

  1. The change in implied volatility for a change in the strike price
  2. The change in option premium for a one-unit change in the underlying futures price Correct answer.
  3. The probability that the option will be exercised at expiry
  4. The change in option premium for a one-day change in time to expiry

Explanation

Delta is the sensitivity of the option premium to a small change in the price of the underlying, and it ranges between zero and one for calls and zero and minus one for puts. It is also used, with caveats, as a rough proxy for the probability of finishing in the money.

Question 46Commodity Futures and Options

A commodity futures contract trades at 4,200 and the contract specifies a lot size of 100 units. What is the notional value of one lot?

  1. 420
  2. 420,000 Correct answer.
  3. 4,200
  4. 42,000

Explanation

Notional contract value equals the quoted futures price multiplied by the contract lot size, so 4,200 × 100 = 420,000. This notional value is used to compute the percentage margin and to size hedges against physical exposure.

Question 47Commodity Futures and Options

What is the primary role of the clearing corporation in a commodity derivatives exchange?

  1. To advise members on which commodities to trade
  2. To set the spot price of the commodity each morning
  3. To act as the central counterparty and guarantee settlement of every trade Correct answer.
  4. To approve the hedging limits of physical market participants

Explanation

The clearing corporation interposes itself between buyer and seller through novation, becoming the central counterparty, and backs performance with a settlement guarantee fund and margin. This removes counterparty credit risk between the original trading parties.

Question 48Commodity Futures and Options

Which statement about the daily mark-to-market process for commodity futures is correct?

  1. Mark-to-market applies only to options and not to futures
  2. Gains and losses are settled only when the position is closed out
  3. Gains and losses are settled in cash daily based on the daily settlement price Correct answer.
  4. Only losses are collected daily, while gains are credited at expiry

Explanation

Futures are marked to market at the end of each trading session using the daily settlement price, and the resulting profit or loss is debited or credited to the member's account. This daily cash flow is what distinguishes futures from forwards and prevents large unrealised losses from accumulating.

Question 49Commodity Futures and Options

A farmer wishes to lock in a selling price for a crop to be harvested in two months. Which strategy is the standard short hedge?

  1. Buy futures now and sell the physical crop at harvest
  2. Sell futures now and buy them back when the crop is sold Correct answer.
  3. Buy put options and also sell call options on the same commodity
  4. Buy call options to protect against a fall in price

Explanation

A producer holding or expecting inventory is long the physical commodity and hedges by selling futures, then offsets the futures position when the crop is sold in the cash market. Losses or gains on the futures offset the change in the cash sale price.

Question 50Commodity Futures and Options

What does a contango market structure indicate for a storable commodity?

  1. Futures prices rise with maturity, reflecting storage and carrying costs Correct answer.
  2. There is an immediate physical shortage of the commodity
  3. Futures prices are below the expected spot price at maturity
  4. The spot price exceeds all futures prices

Explanation

Contango describes an upward-sloping futures curve in which deferred contracts trade above nearby ones, broadly reflecting the cost of carry including storage, insurance and financing. It is the normal structure for commodities with adequate inventories and free storage.